Lots of blame for the financial crisis of ’08 falls on the federal government

There is a huge amount of blame to be spread for the Great Recession that started in 2008. While the recession technically ended four years ago back in June of 2009, most people in California and lots of charities here are still feeling the effects.

I see exquisitely little discussion of how intentional federal policies created the distortions that led to the financial crisis. An op-ed in the Wall Street Journal by Phil Gramm and Mike Solon help explain why much of the blame belongs to the federal government:  The Clinton-Era Roots of the Financial Crisis.

To make this non-partisan, I’ll point out that the flawed policies from the Clinton administration were ratified, continued, and extended by the Bush administration. Not to worry, both parties have worked lots of overtime to earn their share of blame.

While you can argue on the proportionate blame between the two parties, I’ll point out that regardless of the allocation you determine, 100% of that particular allocation falls on deliberate federal policy.

Initial efforts to persuade private pension plans to fund low-income housing failed. The administration forced

…Fannie Mae, Freddie Mac and the commercial banking system into the affordable-housing effort [by]…  exploiting a minor provision in a 1977 housing bill, the Community Reinvestment Act, that simply required banks to meet local credit needs.

Bank regulators began to pressure banks to make subprime loans. Guidelines became mandates as each bank was assigned a letter grade on CRA loans. Banks could not even open ATMs or branches, much less acquire another bank, without a passing grade—and getting a passing grade was no longer about meeting local credit needs.

Under CRA, lenders had to make the regulators happy, and making them happy meant writing loans to people who couldn’t repay based on traditional lending criteria.

Fannie and Freddie created more pressure by being forced to buy up more and more subprime loans. The article outlines the requirements pushed onto the agencies:

Effective in January 1993, the 1992 housing bill required Fannie and Freddie to make 30% of their mortgage purchases affordable-housing loans. The quota was raised to 40% in 1996, 42% in 1997, and in 2000 the Department of Housing and Urban Development ordered the quota raised to 50%. The Bush administration continued to raise the affordable-housing goals. Freddie and Fannie dutifully met those goals each and every year until the subprime crisis erupted. By 2008, when both government-sponsored enterprises collapsed, the quota had reached 56%.

Just to make the point again, by 2008 over half the loans funded through Fannie and Freddie were subprime. Those two agencies were driving the subprime market.

I like tables. Here are the quotas for subprime loans in table format, according to the article:

  • 1993 – 30%
  • 1996 – 40%
  • 1997 – 42%
  • 2000 – 50%
  • 2008 – 56%

Notice that dramatic runup covers administrations of two different parties.

Were there a lot of dollars involved? Um, yeah:

According to the nonprofit National Community Reinvestment Coalition, total CRA lending rose to $4.5 trillion in 2007 from $8 billion in 1991.

Here’s the increase over 16 years:

  • $       8 billion – ’91
  • $4,500 billion – ‘07

For every $1 subprime lending in ’91, there was $562 loaned in ’07.

The article cites a study by The American Enterprise Institute which quantifies the portion of Fannie and Freddie loans that met the traditional definition of a prime loan (large down payment, documented capacity to repay). They calculated:

  • 1990 – 80% of new loans were prime
  • 1999 – 45% were prime
  • 2007- 15% only

The market was flooded by subprime loans forced by federal law.

Those terrible, evil, vicious, greedy, good-for-nothing lenders and underwriters and rating agencies and banks and mortgage brokers and auditors usually get 100% of the blame for the financial crisis.

Theres’ no doubt each of those sectors worked hard to earn their huge share of blame. At the same time, let’s remember that they were responding to requirements of federal policy.

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